Two years ago, the repeat players in the world of shareholder class action litigation--plaintiffs' and defendants' lawyers, along with D&O carriers and their coverage counsel--consulted fortune tellers (or worse, each other) to foresee how the Private Securities Litigation Reform Act would change their professional lives. Would honest businesses be hit with fewer frivolous claims? Would companies purchase less D&O liability insurance? Would securities litigators have to retool and learn to read patents?
Since then, the revolutionary changes that some hoped (and others feared) would occur have not--yet. With any major reform, it takes time for the new rules to become part of the legal system and begin to alter behavior. The number of district court decisions construing the Reform Act is still small and the volume of appellate decisions is minuscule. But while it's too early to draw long-term conclusions about the efficacy of the Reform Act, various tactical battles during the past two years are worth noting.
Friendly Forum Searches
A hallmark of securities litigation during the last two years has been plaintiffs' search for a hospitable home. The plaintiffs' bar's immediate reaction to the Reform Act was to shun federal court. Particularly in California--which does not have the uniform blue-sky provisions of most states--plaintiffs flooded the state courts with cases asserting novel expansive theories under state law. Plaintiffs' rationale was twofold: to try to expand state laws substantively, thereby making recovery easier than under federal law; and to obtain quick discovery for use in drafting a federal complaint. Unlike the old days--in which a plaintiff could sue first and find evidence later--the Reform Act barred plaintiffs from obtaining discovery in federal court until their complaint survived a motion to dismiss. This discovery stay has been a major irritant to the plaintiffs' bar.
In my opinion, plaintiffs' state court gambit has been a failure. While others may disagree, I base that conclusion on three factors. First, plaintiffs' attempts to broaden dramatically state laws that have been on the books for years have not worked. Courts have consistently rejected attempts to apply to shareholder disputes statutes that impose lower burdens, or greater penalties, than do securities laws.
Second, I believe that plaintiffs have come to realize that they will not be permitted to use courts in a particular state (i.e., California) to litigate the claims of shareholders around the country--particularly when federal law provides ample remedies for nationwide classes. This issue is now before the California Supreme Court (in the Diamond Multimedia case). If the court rules that the California securities laws only apply to investors who purchase their stock in that state, the potential damages in these cases will drop to a fraction of their current bloated size. If the court holds that California rules the nation, then one can expect that pending legislation in Congress to preempt state securities laws for nationally traded companies will move to the fast track.
Finally, plaintiffs have not had much success milking the state cases for discovery that they can then use to file a federal complaint. In a number of recent state court decisions (starting with the Quantum case), courts have barred plaintiffs from sharing information between the different cases. Other courts have simply stayed discovery in the state case until federal motions to dismiss were over.
As a result of these factors, many shareholder class actions filed in recent months have been brought exclusively in federal court, without a tag-along state case. (On the other hand, some plaintiffs' lawyers have continued to file state court class actions--suggesting that despite their lack of success in state courts, congressional legislation is needed to plug the loophole.)